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Monday, March 31, 2014

SPX and USB: Equities May Be Plotting a Head-Fake Whipsaw

On Friday, I mentioned that I believe the market is finally close to breaking out of the month-long trading range, and after studying the charts further this weekend, I increasingly believe that break will happen over the next few sessions.

I've done things a little differently today, because the chop zone of the past month has left open at least four fully-valid near-term wave patterns -- and trying to talk about four different options would simply confuse most readers. So instead of doing that, I've simplified the S&P 500 (SPX) chart down to the key price pivot zones, and the next targets if those zones are broken.

I suspect the market is setting up for a whipsaw head-fake break from this range, so watch carefully for the first directional range break to reverse near the pivots. I'll discuss this in more detail after the chart.

While calling direction from the middle of the range in a choppy market like this is virtually impossible, if I had to pick a direction here, I'd say we rally first to run the bear stops, then reverse.

Let's talk about where these price pivots come from, why those pivot levels could mark reversal zones, and thus why (ironically) bulls probably want to see SPX head directly lower, while bears probably want to see it head directly higher.

Disclaimer: If you're easily confused and/or have a short attention span, you might want to skip the next four paragraphs. I've noted where to pick up again.

If SPX heads directly higher, there are two wave counts that remain in play -- and both have
intermediate bearish potential and hint at a reversal to follow. The basic issue for bulls is that an immediate rally would suggest that the three-wave structures of the past month have been part of a triangle. That triangle has two possible forms:

1. The most bearish is the potential ending diagonal rally (discussed last week), which is invalidated north of 1887. Ending diagonals (as the name implies) are terminal patterns.
2. The second option (a standard triangle) is more near-term bullish, but bearish on an intermediate basis. Triangles most often occur as the penultimate wave in a pattern. The thrust out of Elliott Wave triangles is generally strong and fast -- and then reverses nearly as quickly.

So (as noted last week) I think bears want to see prices head directly higher from
here, and then watch for whipsaws starting at either 1885-87 or
1900-1910. Both price zones have the potential to mark intermediate turn
zones. There are, of course, also more bullish options that would remain in play on a breakout, and those come to the fore if SPX can sustain trade north of 1910 +/-.

As I discussed a week ago, the problem for bears is
that the three-wave rally into the all-time high strongly suggests that
the final high isn't in yet. So, in the event of an immediate break lower, the first option for bulls is for an ending diagonal C-wave down. That pattern is invalidated below 1832.82 (hence the 1833 pivot), which, probably not coincidentally, lines up nicely with the 50 day moving average at 1834.

NOTE: Fed governors start reading again here.

If SPX sustains trade south of 1832.82, then a host of bearish potentials open up. So, even though bulls have the three-wave rally into the highs in their back pockets, I would not want to be long south of 1832. The potential for drawdown beneath 1832 is significant. As an extreme example: the 2011 mini-crash came on the back of a three-wave rally into the 2011 high -- and while the market ultimately recovered and exceeded that high, there was much more money to be made on the short side for several months.

Conversely, in the event of an immediate rally, do keep in mind that this is a bull market; which means bears should choose their entries and exits selectively and cautiously, and not stubbornly fight the tape. The wave iii of v count discussed at length during March is still alive and well.

Recently, I've had a few readers request updates on bonds, and there's really very little to add since my last bond update of February 20. Near-term, the 30-year bond (USB) may still be working on wave B/(2). Ultimately, I still expect prices to test 138, though bullish bond bets are off below the key overlap.

A chart that bears watching is the ratio of high yield corporate bonds to Treasury bonds (HYG:TLT), which has broken its up-sloping channel for the first time in nearly two years. The bond charts may be warning that there's trouble on the horizon for equities, but as yet there have been no definitive red alerts here, only hints and allegations.

In conclusion, while SPX is still within the trading range, I'm anticipating it will break from this range in short order. I further suspect that the first break will be upwards, but would stay very cautious for a head-fake and whipsaw shortly thereafter. The market, of course, reserves the right to do something else entirely -- so the key levels should help point the way. Trade safe.

Follow me on Twitter while I try to figure out exactly how to make practical use of Twitter: @PretzelLogic

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